3/29/2010 @ 7:35PM

Governments Guilty Of 'Repo 105' Accounting

Hiding liabilities from plain view is a despicable practice that’s caused corporations and their investors irreparable damage. Despite the justifiable anger aimed at Wall Street over such practices, others have proven equally adept at such deception.

Take the U.S. government, for instance. It’s actually quite proficient at hiding liabilities off its balance sheet. Many states also have learned the art of making numbers tell whatever story is in their best interests. Two categories of sleight of hand have gotten particular attention recently.

Everyone knows that
Fannie Mae
and
Freddie Mac
are monumental financial disasters. They were originally conceived of as guarantors of mortgages to accommodate the needs of U.S. citizens in their desire to secure home financing. They evolved into abominations that were one part insurer and one part hedge fund.

On one side of their books they would guarantee mortgages. On the other, they would gamble on mortgage-backed securities. Why did they bastardize their mission? The mortgage side of the book helped politicians win votes from homeowners. The mortgage-backed securities side helped Fannie and Freddie executives pump up their stock prices and reap vast stock options gains.

Common sense suggests that the government should have figured out how to marginalize the role of such poorly run institutions. Instead, the feds figured out how to perpetrate their own version of the so-called Repo 105 transactions that Lehman Bros. used to mask its own insolvency, according to its bankruptcy examiner. (Lehman Bros. is now a part of
Barclays PLC
.)

As the Federal Reserve System stops purchasing mortgage-backed securities, the government has no desire to further crater the housing market. Nice trick: The Fed removes junk from its balance sheet by shuffling it out of sight into Fannie and Freddie, which have been granted unlimited capacity to swell their balance sheets.

State Pension Funds

Unfortunately, states are playing similar Repo 105-style games. A dozen or so articles have recently been written on the “hole” in public pension funding–meaning the vast unfunded liability. This is a topic we’ve been screaming in the woods about for a decade. Ten years ago we warned that bankruptcy loomed for baby boomers, unless we increased pension investment returns, limited public sector pension and health care benefits and increased contributions.

The only thing that’s changed is that many baby boomers are now retiring. The states are coping by kicking the can down the road and using unrealistically high investment return assumptions, coupled with “smoothing techniques.” Together, these delay the day of reckoning.

State and local pension plan officials should be marking securities to market and using actuarial assumptions that bear some semblance of the reality. Instead, plan participants and taxpayers are handed a fiction by the accountants, actuaries and trustees. The numbers released for public consumption are a far sight rosier than the trillions in unfunded liabilities outlined by academics at the Center for Retirement Research at Boston College and the Pew Center on the States.

Politicians, meanwhile, ride along on their high horses taking swings at bankers for blowing up the financial system. They want to prosecute those whose fraudulent intentions masked the truth from investors and employees. They should. But we as citizens should also ask who is going to hold the politicians accountable for turning a blind eye to the financial crimes being perpetrated by some state and local pensions.